Borrowers may be tempted to skip student loan payments and instead spend their money on gifts, meals and decorations for the holidays. After all, the pressure to give and entertain grows only more intense as Christmas and New Year's draw closer.
But doing so could ding your credit score, experts have warned, prompting the Biden administration on Tuesday to issue its warning in a letter to credit reporting agencies not to do that. Instead, the companies should exhibit some grace to 28 million borrowers considering the extenuating circumstances of restarting student loan payments after a more than three-year pause, Richard Cordray, chief operating officer of the Office of Federal Student Aid, wrote in a letter obtained by USA TODAY.
Student loan interest started accruing on Sept. 1, and payments restarted in October.
The Biden administration promised borrowers a 12-month “on-ramp” through Sept. 30, 2024, so those who don’t make payments aren't reported to credit bureaus, considered in default, or referred to collection agencies for late, missed or partial payments. But it also noted that “we do not control how credit scoring companies factor in missed or delayed payments.”
So, while it’s true that nonpayers are shielded from the harshest consequences of late, missed or partial payments, interest will accrue and swell their balances. That growing balance is what could depress your credit score, experts said.
“If the increasing outstanding balance on that loan is reported to the credit bureaus, that could result in a modest negative impact to the score,” said Tommy Lee, senior director of analytics and scores at credit scorer FICO.
Now, the Biden administration wants to prevent that, too. It would be “inappropriate” for credit-scoring models to rely on things like a small uptick in loan balance due to interest accruing, periods of forbearance, monthly payment amount, or other signs of a reduced or missed payment, as a sign of creditworthiness during this period, Cordray said.
"These are unique circumstances, and the standard inferences that credit scoring models might normally draw from individual payment behavior should be considered differently than before the payment pause began," Cordray wrote.
"Additionally, creditors who rely on your data may not understand that various factors related to student loan payments now and in the near future do not carry the same creditworthiness implications as they do for other products," he wrote."
What did the Biden administration tell credit reporting companies?
In the letter, Corday emphasized that missed payments are happening in a "fundamentally different context than any other time and are a substantially less reliable indicator of unwillingness or inability to pay."
The administration is "concerned that servicing errors and other unique factors could impact the accuracy of your credit models and consumer data about borrowers during the current special circumstances of the return to repayment," he said.
Cordray "strongly" urged the credit reporting agencies from making "negative assumptions about missed student loans" in credit scoring models."
In recent months, Cordray said his department "identified multiple errors loan servicers made in calculating and informing borrowers about their loan payments. For example, several loan servicers provided inaccurate disclosures to nearly 100,000 borrowers."
Another loan servicer failed to provide timely billing statements to nearly 2.5 million borrowers, the letter said, "resulting in many borrowers not receiving a timely notice for when their payments were due." The Department of Education directed servicers to place affected borrowers into an administrative forbearance, so they will be held harmless while the errors are resolved, Cordray wrote. But the result of of the errors and a borrower's lack of payment "does not necessarily reflect their ability or intention to repay their loan," he wrote.
He also urged the companies "to reevaluate your approach, and ask that a borrower’s creditworthiness not be evaluated by a system designed for pre-pandemic circumstances.”
None of the three largest credit reporting agencies – Equifax, Experian and TransUnion – released public comments on their websites regarding the Cordray letter.
In response to an inquiry from USA TODAY, TransUnion said credit reporting agencies are required to report certain data furnished to them according to the Fair Credit Reporting Act.
“To that end, the decision over whether a balance appears on a credit report will ultimately be decided by the entities who furnish that information and the relevant legislative and regulatory bodies who write and enforce those laws, while the decision to use that information in lending decisions will ultimately be made by the lenders themselves," TransUnion said.
Experian and Equifax did not submit comments to the inquiry.
Why is a good credit score important?
Companies use credit scores to decide whether to offer you a mortgage, credit card, auto loan, and other credit products, as well as for tenant screening and insurance. Lenders also also credit scores to determine the interest rate and credit limit you receive.
A high credit score will often snag you the best terms on a loan and prevent you from having to pay more for a loan.
How exactly is your credit score calculated?
Though each credit scoring company has its own formula to calculate credit scores, they all consider five factors:
Payment history: The most important information any credit scoring model considers is whether you pay your bills on time. For example, the bulk of your FICO Score − 35% − comes from your payment history.
Amounts owed: How much debt you’re carrying also affects your credit score; it accounts for 30% of your FICO score. Credit utilization − the percentage of your available credit in use on your credit cards − can have a major impact on your credit score.
Credit history: A longer track record of managing credit can help your credit score. Length of credit history is worth 15% of your FICO score, for example. To determine the length of credit history, FICO looks at various factors, including the age of your oldest account, the age of your newest account, and the average age of all your accounts together.
New credit: When you apply for a new loan, credit card or other financing, a lender may make a hard credit inquiry, which is a credit check used to make a lending decision. A hard inquiry may cause a slight dip of less than 5 points, which can affect your score for about a year. One or two hard inquiries shouldn’t have too much effect, but too many in a short time could hurt your score. This makes up 10% of your credit score.
Credit mix: Various types of accounts − for example, having an auto loan, a mortgage, a personal loan and a few credit cards − is considered a plus. Credit mix is worth 10% of your FICO score.
How much would your credit score dip if you made no student loan payments during the 'on-ramp'?
The influence student loan debt will have on a credit score will vary from person to person, “depending on both the details of that consumer’s student loan(s) as well as their overall credit profile,” FICO's Lee said.
Generally, lower balances are viewed positively. The converse is also true: If you're not paying down the student debt and the interest is accruing, making the balance swell, it can be a modest negative for your credit score, he said.
How soon could you see your credit score dip?
Account information is usually updated on credit reports monthly, and the credit score can be updated to reflect those changes immediately, Lee said.
What can borrowers do?
Borrowers who miss payments should monitor their credit reports and scores and try to make what payments they can to keep their balance in check.
Some credit reports are provided free through financial institutions or other providers. All consumers can receive a free copy of each of their three credit reports from credit bureaus Equifax, TransUnion and Experian weekly through AnnualCreditReport.com or by calling 877-322-8228.
If you can’t make any payments, review your payment options. Those include income-driven repayment plans based on family size and income that can lower your payments and fast-track you to forgiveness. The newest income-driven program, SAVE, is expected to generate the lowest payments for most borrowers and can be as low as zero for those with lower incomes.
What is a good credit score, and why is it important?
However, if you hope to qualify for the best interest rates and terms from lenders and credit card companies and improve your approval odds, you should aim for a credit score of 740 or higher (very good credit or exceptional credit).
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at email@example.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.
Betty Lin-Fisher is a consumer reporter for USA TODAY. Reach her at blinfisher@USATODAY.com or follow her on X, Facebook or Instagram @blinfisher.
This article originally appeared on USA TODAY: Missed student loan payments shouldn't tank your credit score: Biden